What is your property worth? Chances are someone in India is answering that question for your lender without ever stepping foot in the country, let alone in the property. The process of using a Broker Price Opinion for valuation was outlawed in the last crisis, but there is a gaping hole. This is where India fits into the picture. The crazy part is the U.S. government is supporting this industry practice putting taxpayers on the hook for millions in losses. Sound familiar?
There are new rules and new ways to skirt the rules. After everyone lost their shorts in the last crisis, Congress wizened up and outlawed the practice of using a BPO for a traditional mortgage. The problem is the majority of mortgages are no longer traditional mortgages. For example, when Blackstone wanted to borrower hundreds of millions of dollars to buy houses, to save money and time they turned to BPOs. These loans are packaged and later sold as bonds to various investors including banks, wall street, and the federal government.
The United States Government supports this practice. Fannie Mae (a government housing arm for all intensive purposes) has insured millions in bonds relying on BPOs for their values which means at the end of the day US taxpayers are once again on the hook when the market goes south.
How does India fit into the picture? The price paid for Broker Price Opinions has dropped to around 25 dollars; to save money and time, many of these tasks are now outsourced to India for a few dollars. The outsourced companies utilize google earth and real estate websites to determine the value. Basically, they are providing the same thing as Zillow’s Zestimate. We all know the Zestimate can be grossly wrong in many instances (why your zestimate sucks). Billions of dollars in bonds are now dependent on these inaccurate values.
Fannie Mae even noted in a bond prospectus for Green River Capital that the “market values of the properties many not be accurately reflected” (source Wall Street Journal). This gives you the warm and fuzzy feeling inside! Isn’t the intent of a market valuation to provide the value of a property. If that is not the case, then what is the point?
Why is this important? The number one indicator of whether a lender or investor loses money on a transaction is loan to value. If the value piece is overstated using a BPO the true riskiness of the underlying security is considerably higher. For example, in a security and investor purchasing a bond might assume that the loan to value of the portfolio is 80% when in fact due to the inflated values the real loan to value is over 90%. The risk of loss just increased substantially.
Just like a balloon, real estate eventually must go down. It is easy to make money in an up market. When everything is going up the only real requirement is to hop a seat on the bus and hang on for the ride. When the market goes down is when the true separation in the market occurs. We saw during the last crisis that many bonds collateralized by real estate became underwater quickly. The same thing is likely going to happen in the next crisis as values for many bonds are currently overstated.
The last crisis is being forgotten. The last crisis is a long-gone memory to most in the industry today. The usage of BPO’s leaves a gaping hole in the financial stability of the bond market that relies on accurate values. Once the next cycle begins the true values will quickly become apparent and bond holders will be wondering what happened just like the last time. Don’t forget you and I are on the hook for many of the losses since Fannie Mae insures many of these portfolios. The losses will ultimately be held by the taxpayers when the government bails out Fannie and Freddie just like last time. Although history rarely repeats itself word for word, as Mark Twain said, “it often rhymes”. Are you ready for the next verse in the rhyme?
I need your help!
Don’t worry, I’m not asking you to wire money to your long lost cousin that is going to give you a million dollars if you just send them your bank account! I do need your help though, please like and share our articles it would be greatly appreciated.
Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).